Investors were rattled by weekend news that the European Union and International Monetary Fund have demanded that all bank customers in Cyprus pay a levy in return for a €10 billion ($12.9 billion) bank bailout. How Cyprus wrong-footed global markets

The reports triggered worries of a run on European bank deposits, especially in other heavily indebted euro-zone countries such as Spain and Italy, and brought back painful memories of prior crises in the region that have done lasting damage to markets.

“For the U.S. it doesn’t mean a huge amount, but we know confidence shakes all markets. This is a market that’s not cheap in any shape or form,” said Chris Weston, chief market strategist at IG in Melbourne, Australia. “It’s been stretched. It doesn’t take a lot to cause a pullback when you’ve got these conditions.”

Talk of a correction in U.S. markets has been increasing over the past couple of weeks. Year-to-date, the Standard & Poor’s 500 index
SPX, -1.42%
has gained nearly 9%, but it recently failed to take out its all-time closing high of 1,565.15, hit in October.

The Dow industrials
DJIA, -1.35%on Friday ended the longest winning streak by the index in more than 16 years, closing down 0.2%. Analysts said the market had been looking for any excuse to take a breather.

IG’s Weston said investors could expect to hear talk that a 5% retreat is likely for U.S. markets on the back of Cyprus worries. He says that’s the “usual throwaway line that gets used. We’ve had 10 days of making higher highs in the U.S. and I think markets were getting overstretched.”

The next big event for investors is a vote in Cyprus on the bailout package, which media reports said has been delayed so that ministers can revise the plan in order to ensure it passes. “Ultimately, if they vote against it, Cyprus doesn’t get its money. Then it’s going to go bankrupt, which could be even worse,” said Weston.

Reuters

A man withdraws money from an automatic teller machine at a branch of Bank of Cyprus, in Athens March 16, 2013.

Fawad Razaqzada, market strategist at GFT Markets, said markets will be sensitive to news out of Cyprus. “And it goes without saying that after the protracted gains we’ve seen of late, there are certainly some healthy profits out there to be booked.”

Also this week, the Federal Reserve will meet. A statement is due Wednesday, along with a press conference from Fed Chairman Ben Bernanke. Most investors think the Fed will keep its ultra-loose policy in place, but any indication that the central bank is changing its policy could trigger a pullback for Wall Street, analysts said. Check out weekend Market Snapshot

The euro fell sharply on fears of renewed turmoil in the euro zone, with investors moving into the perceived safety of the U.S. dollar. Gold prices also moved back above $1,600 an ounce, after being hard hit this year.

Concerns worth repeating

Dan Greenhaus, chief global strategist with BTIG in New York, said in a note published on Monday that concerns that the firm has cited in recent weeks -- gasoline prices that at current levels are coincident with stock pullbacks, NYSE stocks over the 200-day moving average, the S&P’s distance from the daily moving average — bear repeating in the wake of the Cyprus news.

“We have noted repeatedly that investors simply stopped caring about Europe, and perhaps this time will be no different. Or perhaps investors will feel this moment as right for a pullback, the 2013 version of exactly what was seen in 2010..and 2011 ... and 2012,” said Greenhaus.

Still, he appeared to be preaching from a no-panic position. “The big question now is whether this [Cyprus tax on deposits] spurs bank runs in other countries; we’re not so sure it does, and while risk will be higher tomorrow than yesterday, panic should not ensue. As for the other countries? Well, Ireland and Portugal got easier bailout terms,” he said in the note.

On Friday, former Fed Chairman Alan Greenspan told CNBC the latest rally in U.S. equities has been fueled by the temporary removal of euro-zone concerns and other tail risks, rather than “irrational exuberance,” the term he coined in 1996.

However, that differed with bond guru Bill Gross, who wrote in his March investment outlook that “on a scale of 1-10 measuring asset-price ‘irrationality,’ we are probably at a 6 and moving in an upward direction.”

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